- 18 Mar
The Pros And Cons Of Invoice Discounting For Businesses Considering Using Invoice Discounting
Below I have published a list of the pros and cons of factoring and so to complete the record I have also published a list of the pros and cons of invoice discounting for the benefit of any businesses that are considering using invoice discounting.
Many pros and cons are similar for factoring and invoice discounting (both products are forms of invoice finance), but there are some subtle differences:
Pros Of Invoice Discounting
- Improved business cash flow & cash lump sum released - when you first start using invoice discounting you can release a large proportion of the cash that is tied up in your unpaid sales invoices.
- Funding grows with your business - the more invoices you raise, the more funding is released, unlike a traditional bank overdraft or loan, where the funding is a stated amount. Hence, the funding from invoice discounting grows with your business.
- Protection against bad debts (optional) - many invoice discounting companies offer protection against bad debts (non-recourse invoice discounting) as an option.
- Confidentiality - invoice discounting is often available on a confidential basis so that your customers are not aware that you are using an invoice discounting facility.
- Control of customer contact - with invoice discounting you retain the credit control and invoice collection function for your business in-house, so you remain in control of the contact with your customers.
Cons Of Invoice Discounting
- Cost - there is a cost to use an invoice discounting service. Having said that you can shop around to find the best deal for your business. You can also offset the cost by having improved cash flow which can mean being able to demand discounts from suppliers.
- Minimum charges - some invoice discounting facilities will have minimum monthly or annual charges. These vary dramatically between different providers and there are also specialist invoice discounting facilities that do not require you to pay any kind of minimum charge and still allow you to collect your invoices.
- Security requirements - additional security such as personal guarantees may be required. Some invoice discounters may be prepared to limit these substantially.
- Contract length & being tied in - many invoice discounting companies will require a minimum contract length and lengthy notice periods. Again this is not universal and you need to shop around. Some invoice discounters offer very short notice periods for termination of the facility.
- You don't have help collecting your sales ledger - unlike factoring, invoice discounting does not provide you with a credit control function to help you collect your unpaid sales invoices.
- Set-up process - in some cases, the set-up process for invoice discounting can be lengthy and complicated. Again this is not universal and there are significant differences between different invoice discounting companies.
We’re also running a quick AI + invoice finance survey for 2025 - it only takes 2 minutes to complete and helps us understand how businesses use tools like ChatGPT alongside invoice finance. Would you spare a moment to take the survey?
Explaining: What Are The Pros And Cons Of Factoring?
The pros and cons of invoice factoring services are explained below. You can also see a short video about them here.
The Positives And Negatives Of Using Factoring
The Advantages Of Invoice Factoring
Immediate Access to Cash
One of the primary benefits of invoice factoring is the immediate liquidity it provides. Instead of waiting for weeks or even months for a client to pay an invoice, businesses can receive a significant portion of the invoice value almost instantly. This can be particularly beneficial for businesses with tight cash flow or those looking to invest in growth opportunities.
Reduced Risk of Bad Debts
With invoice factoring, the risk of non-payment is sometimes transferred to the factoring company (called non-recourse or bad debt protection). This means that if a client defaults or delays payment, it's the factoring company's responsibility to chase the payment, not the original business's. This can provide peace of mind and reduce the administrative burden of chasing late payments.
Outsourced Credit Control
Many factoring companies offer credit control services as part of their package. This means they will handle credit checks, payment reminders, and even debt collection in some cases. For businesses without a dedicated credit control team, this can be a significant advantage.
Flexibility
Invoice factoring can be a flexible solution, with businesses using selective facilities being able to choose which invoices they want to factor into their facility. This means they can use it as and when they need it, rather than being tied into long-term contracts. In other circumstances, the user may want to factor all of their invoices to maximise funding levels.
The Disadvantages Of Invoice Factoring
Cost
One of the most significant drawbacks of invoice factoring is the cost. Factoring companies charge fees for their services, which can eat into a business's profit margins. It's essential to weigh up these costs against the benefits of improved cash flow.
Dependence on Clients' Creditworthiness
The amount a factoring company is willing to advance often depends on the creditworthiness of a business's clients. If a client has a poor credit history, the factoring company may offer a lower advance rate or even refuse to factor the invoice altogether.
Potential Impact on Customer Relationships
Some businesses worry that using a factoring company can harm their relationships with clients. This is because the factoring company, not the original business, will be responsible for chasing late payments. It's crucial to choose a factoring company with a good reputation and ensure they treat clients with respect.
The Hidden Benefits of Invoice Factoring
Focus on Core Business Operations
With the administrative burden of chasing invoices taken care of by the factoring company, businesses can redirect their focus and resources towards core operations. This can lead to improved efficiency, productivity, and ultimately, profitability.
Financial Reporting Benefits
By converting accounts receivable into immediate cash, businesses can present a healthier balance sheet. This can be particularly advantageous when seeking external investments or loans.
Competitive Edge
Having a steady cash flow can provide businesses with a competitive edge, allowing them to take advantage of bulk purchasing discounts, invest in research and development, or launch marketing campaigns ahead of competitors.
The Lesser-Known Drawbacks of Invoice Factoring
Perception Issues
There's a perception in some industries that businesses resort to invoice factoring only when they're in financial trouble. This can lead to potential image issues, with partners or clients questioning the company's stability. However, this view is largely redundant these days as more and more SMEs have turned to this type of funding for cash flow support.
Loss of Control Over Customer Interaction
While outsourcing credit control can be seen as a benefit, it also means businesses lose some control over their interactions with customers. The factoring company's approach to debt collection may not align with the original business's values or customer service standards if the wrong partner is selected. As there are over a hundred factoring provider options in the UK alone, it's important to make the right choice.
Contractual Limitations
Some factoring agreements come with stipulations that may limit a business's flexibility. For instance, a contract might require a company to factor all its invoices or maintain a specific volume of invoices. Shopping around is essential to find the right deal for you.
Summary And Conclusions
As discussed above there are factors on each side of the equation to be weighed up when you are considering using invoice discounting or factoring services.
In most cases, the most important factor tends to be the improved cash flow that can be delivered by these products. There are also product options that can mitigate and overcome most of the other drawbacks.
The Pros And Cons Of Invoice Discounting For Businesses Considering Using Invoice Discounting
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